Understanding Home Equity Loans And Lines Of Credit

Over the past few decades the popularity of home equity loans and lines of credit has dramatically risen. They provide a convenient way to get money for large purchases, to cover emergency expenses or to consolidate debt. These loans are different than other types of loans in that they are borrowed against the value of your home. Understanding home equity loans and lines of credit starts by first understanding the differences between these loans and personal loans or credit cards.

Main Advantages of Home Equity Loans

One of the main advantages that these types of loans offer over other borrowing options is that they tend to have extremely low interest rates. Because of this, people often use these loans to consolidate their credit card debt. By taking out a home equity loan that is large enough to pay off all of their credit cards, they can significantly reduce the interest rate on their debt, saving them money and making it easier to pay off quickly.

How Much Can I Borrow?

The amount of money that you can borrow is determined by the amount of equity that you have in your home. Equity is the difference between the value of your home and the amount of money that you owe on it. It is calculated by first adding up the total amount of money that you owe on your home including any first or second mortgages. This figure is then compared to the total value of your home. This comparison provides what is known as a loan-to-value (LTV) ratio. In most cases, lenders are willing to lend up to 80% of the homes value, although you may be able to find some banks that are willing to go higher than that.

How Home Equity Loans Are Given

Home equity loans are given as a large lump sum payment. They are added on as a second mortgage and are secured by your property. If you default on your loan, any money that is made from the sale of your home is applied first to your primary mortgage. The money remaining after the primary mortgage is paid off is then applied to the home equity loan. Most home equity loans have a fixed interest rate which means that you will pay the same amount of interest for the life of the loan.

How Home Equity Lines Of Credit Are Given

Home equity lines of credit are slightly different. Rather than giving you a large lump sum payment, the bank sets up a line of credit that you can borrow money from anytime you need it until you reach your credit limit. The credit limit is determined by the value of your home.

Which Should I Use?

Home equity loans are usually good for making large purchases since all of the money is dispersed at once. Home equity lines of credit, on the other hand, are generally used to cover emergency expenses since smaller amounts of money can be borrowed whenever you need them.

Understanding home equity loans and home equity lines of credit is relatively easy when you realize that they are simply loans that are borrowed against the value of your home. These loans can be a good way to cash in on the equity that you have built in your home without having to sell it.